If part of your pay arrives as company stock, you are not alone. Equity compensation has become a standard part of offers at technology companies, startups, and an increasing number of established firms. It can be a meaningful component of long-term wealth, but it also introduces complexity: vesting schedules, tax withholding rules, and concentration risk that a simple salary never creates.
This article walks through the three most common forms of equity compensation at a high level. It is intended as a starting point for a conversation with your advisor and tax professional, not a substitute for one.
Restricted Stock Units (RSUs)
RSUs are a promise from your employer to deliver shares (or their cash value) once you meet vesting requirements, typically based on time of service. When RSUs vest, the fair market value of the shares is generally taxed as ordinary income, similar to a cash bonus, and your employer usually withholds a portion of the shares to cover taxes.
A common misunderstanding is that the default withholding rate always covers the full tax bill. Depending on your income, it may not, which is one reason many people review their withholding and estimated payments in years with large vesting events.
Incentive Stock Options (ISOs)
ISOs give you the right to buy company shares at a fixed exercise price. They can receive favorable long-term capital gains treatment if you meet specific holding-period requirements, but exercising ISOs can also trigger the alternative minimum tax (AMT) even when you have not sold a single share.
Because the AMT calculation depends on your full tax picture, decisions about when and how many ISOs to exercise are highly individual. Modeling scenarios before year-end, rather than after, generally provides more flexibility.
Non-Qualified Stock Options (NSOs)
NSOs are options that do not meet the requirements for ISO treatment. When you exercise an NSO, the difference between the market price and your exercise price is generally taxed as ordinary income at that time. Any subsequent gain or loss after exercise is treated as a capital gain or loss.
Questions worth asking before your next vesting date
Regardless of which type of equity you hold, a few questions come up in nearly every planning conversation:
- How much of my total net worth is tied to my employer, counting both my shares and my paycheck?
- Do I have a written plan for selling or holding shares as they vest, or am I deciding emotionally each quarter?
- Is my tax withholding likely to cover what I will actually owe this year?
- Do any trading windows, blackout periods, or company ownership requirements affect my options?
The bottom line
Equity compensation rewards patience and planning, and punishes improvisation. Understanding what you hold, how it is taxed, and how concentrated your overall position has become is the foundation for making deliberate decisions rather than reactive ones. A financial planner working alongside your tax professional can help you build a framework that fits your situation.
Important disclosures
This article is provided for educational and informational purposes only and should not be construed as personalized investment, tax, or legal advice. The information presented is general in nature and may not be appropriate for your individual circumstances. Litchfield Financial, LLC does not provide tax or legal advice; please consult a qualified tax professional or attorney regarding your specific situation. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. No strategy, including diversification or asset allocation, assures a profit or protects against loss in declining markets.
Litchfield Financial, LLC provides investment advisory services through Claro Advisors Inc. (“Claro”), a registered investment advisor. Claro Advisors Inc. is a Registered Investment Advisor with the U.S. Securities and Exchange Commission (“SEC”) based in the Commonwealth of Massachusetts. Registration of an Investment Advisor does not imply any specific level of skill or training. Information contained herein is for educational purposes only and is not to be considered investment advice.
